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A year after being discredited, austerity economics still reigns

The world still hasn’t learned its lesson from the Reinhart-Rogoff debacle

It has been a bit more than a year since the Excel spreadsheet error that shook the world. For those who may have missed it, in April of 2013, Thomas Herndon, a University of Massachusetts graduate student in economics, found an error in the calculations of Harvard professors Carmen Reinhart and Ken Rogoff on the relationship between government debt and economic growth.

Reinhart and Rogoff had done an enormously influential analysis showing that countries experienced sharply slower growth once their debt-to-GDP ratio exceeded 90 percent. With the United States and many European countries reaching debt-to-GDP ratios in this 90 percent range in the wake of the Great Recession, Reinhart and Rogoff’s work was seen as a warning. It was taken as evidence that governments would have to reduce spending, raise taxes or both to get or stay below the 90 percent threshold.

Political leaders and central bankers around the world were happy to trumpet the Reinhart-Rogoff findings. The story was that cutting deficits may slow growth in the short term and seriously hurt those directly affected by the cuts, such as laid-off government workers, but it was essential medicine for sustaining a healthy economy.

The spreadsheet error uncovered by Herndon and analyzed in a paper co-authored with two University of Massachusetts professors, Michael Ash and Robert Pollin, showed that the Reinhart and Rogoff story not only was based on an embarrassing gaffe but also was not true. Working off the spreadsheet that Reinhart and Rogoff created, Ash and Pollin showed there was no 90 percent cliff. Reinhart and Rogoff’s red line depended on the spreadsheet error and a peculiar way of aggregating growth rates across countries.

If the numbers were entered correctly and added up across countries with more typical methods, growth did not fall off steeply for debt levels above 90 percent. The data still associated higher debt levels and lower growth rates, but the sharpest reduction in growth rates occurred with debt levels below 30 percent. That was a very different story from what Reinhart and Rogoff were saying publicly and presumably also in private meetings with central bankers, finance ministers and members of Congress.

Perhaps even more important, a number of new studies looked at the direction of causation between growth and debt. While Reinhart and Rogoff never directly tested for causation, they certainly implied that high debt causes slow growth.

When two prominent economists can make a major error on work that had a huge impact on economic policy and face no real consequences, it says a great deal about the incentives in the economics profession.

After the discovery of the spreadsheet error, severalpapers analyzed the Reinhart-Rogoff data and found that the causation was almost entirely from slow growth to high debt. In other words, countries did not run up big debts and then saw their economies slow down. Rather, countries that had serious growth problems tended to run larger deficits to boost growth. Also, if an economy was growing rapidly, its debt-to-GDP ratio declined (other things being equal) as its GDP rose. When a country’s GDP is not rising much, it’s much harder to bring down the debt-to-GDP ratio.

With the academic basis for deficit reduction undermined by this new research, it might have been reasonable to expect there would be a renewed push for measures to stimulate economies and reduce the high unemployment rates that plague most wealthy countries. However nothing like this has happened. The push for deficit reduction in the United States and Europe went on just as before.

The one exception was Japan, where the government of Shinzo Abe embarked on an aggressive stimulus program. He took this path in spite of the fact that Japan has by far the highest debt-to-GDP ratio of any wealthy country — more than 240 percent. And his policies appear to have worked to date, since growth jumped and employment surged.

But Abe embarked on this path even before the spreadsheet error came to light. The economics profession can’t claim that this new evidence was responsible for the change of policies in Japan.

There isn’t much that the economics profession can claim in this debate that makes it look very good. While there is now a large and growing body of evidence that larger budget deficits would boost growth and employment in the current economic environment, those in the political establishment in Europe and the United States seem impervious to evidence at this point. They got all the evidence they needed when they had the Reinhart-Rogoff study to cite. Now that it turns out that Reinhart and Rogoff were mistaken, governments see no reason to re-examine their policies.

It is instructive that Reinhart and Rogoff don’t seem to have suffered much in their professional standing. While both of them have produced a large body of research over their careers so their reputations did not rely solely on the 90 percent analysis, this was a rather egregious error. They justified their mistake by pointing out that it appeared only in a working paper that they had rushed to finish. A revised version of the paper includes the correct numbers.

However, they surely knew that the dramatic 90 percent cliff story from the working paper was being used in policy debates around the world. Knowing that they had been rushed when they wrote that version, surely they had time in the subsequent three years until the error was discovered to re-examine their work or, more likely, have a research assistant scrutinize it. Obviously they never chose to do so. If either of them has suffered any professional consequence from this failure, it is difficult to see what it is.

Economics is a profession that fixates on the idea of getting incentives right. When two prominent economists can make a major error on work that had a huge impact on economic policy around the world and face no real consequences, it says a great deal about the incentives in the economics profession.